How to Think About Synergies

Most discussions on PMI focus on achieving cost synergies—and with good reason. A PMI can change the fundamental cost structure of a business by marrying the strengths of each company in the merger or acquisition.

Such synergies are usually critical to paying for the deal and realizing its near-term value in the capital markets. Since cost synergies are usually communicated to investors and are relatively easy to estimate, they are often factored into the price of the stock once investors are confident that the deal will close.

However, achieving cost synergies shouldn’t come at the expense of potential revenue synergies that can add to the top line over the medium and long term. Revenue synergies are much harder to capture than cost synergies, but they are equally—if not more—important for both financial and organizational reasons.

In order to continue to create shareholder value, an acquirer has to deliver synergies above and beyond expected cost savings. A PMI offers a unique occasion to identify and pursue new opportunities for growth—for example, by cross-selling products, bringing existing products and services into new channels or geographies, or leveraging an improved cost structure to target new customer segments.

In addition, when a PMI is put into the context of a credible and compelling growth story, that story can be an excellent catalyst for employee engagement and motivation. If people in the organization are convinced that the PMI is a step on the way to an exciting future, they are generally more willing to accept the tough decisions that are necessary to get there.

Optimizing Functional Synergies

A merger’s full value often goes unrealized because acquirers tend to view the core business functions through the narrow lens of cost synergies. To unlock the full long-term potential of a merger, acquirers need to think laterally and treat integration not as an isolated functional exercise but as a strategic opportunity to reformulate each function’s role. This will allow each function to play a full and complementary part in optimizing the combined entity’s long-term growth.

IT can generate 15-20% of total synergies—and as high as 30% in information-intensive industries such as banking and retail. It also plays a critical role in enabling other parts of the business to deliver synergies. Companies are most likely to gain these synergies when they:

Develop a dedicated, cross-functional IT integration team.

Design a plan that ensures basic connectivity and appropriate security are available and functioning on day one.

In some industries, such as biopharmaceuticals, R&D talent can be a critical asset acquired in an acquisition. And yet, on average, companies lose 10% of their R&D talent base when an acquisition is announced. As such, the key to maximizing synergies in this area is to retain critical personnel, along with their knowledge and expertise.

Companies must also find a way to create a unified team that mixes and matches the capabilities of both companies. Overcoming these challenges requires four actions:

The purchase of goods and services often represents more than half of a company’s total costs, so procurement usually delivers the lion’s share of total synergies—with savings ranging from 5-25%. Acquirers often underestimate potential savings, however, and many tend to view procurement as simply a numbers game.

PMI provides an opportunity to rethink how to buy and from whom—rather than just how much to purchase and at what price. In particular, significant value can be unlocked simply through more efficient demand management—for example, by standardizing service levels across the two organizations. To exploit these potential savings and optimize synergies, companies need to:

Pursue an in-depth understanding of potential synergies.

Challenge long-established supplier relationships and assumptions.

Question products’ technical specifications.

Reposition procurement at the heart of the company’s strategic decision-making processes.

Optimizing synergies in this function requires companies to first determine the ideal design for the manufacturing network. This decision should be based on strategic considerations, not just costs. Here are some questions to ask:

Will the product be distributed worldwide or does it require regionalized customization?

The biggest challenge in this function is striking the right balance between cost and revenue synergies. Many acquirers believe that significant savings and revenue gains can be made by selling more products through a smaller combined sales force. Unfortunately, this approach can actually lead to a drop in sales. To maximize revenue synergies, companies have to, among other things:

Manage the sales challenges of an expanded portfolio.

Reshape two sets of competing or disparate brands into a complementary portfolio.

Keep customers loyal by proactively addressing their concerns and communicating the benefits of the merger.

Most companies have different financial, operational, and sales processes, which can lead to different levels of working capital efficiency. By attacking this directly and making it a priority, companies can often find an unforeseen cash influx as a result of their planning.

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